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Technology

Prot maximization

Exercises of Microeconomics
Technology and Prot Maximization (Ch. 1-2 Varian)

Fabio Tramontana (University of Pavia)

slides available at: http://tramontana.altervista.org/teaching.html

PhD in Economics at L.A.S.E.R.

Tramontana Exercises Micro


Technology
Prot maximization

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.2

What is the elasticity of substitution for the general CES


technology y = a x + a x when a 6= a ?
 / 1
1 1 2 2 1 2

Let us start by recalling that the elesticity of substitution measures


the curvature of an isoquant and can be calculated as:

TRS d (x /x ) 2 1
=
(x /x ) dTRS
2 1

or, by using the logarithmic derivative:

d ln(x /x )
2 1
=
d ln |TRS |
Tramontana Exercises Micro
Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

We rst need to calculate the technical rate of substitution (TRS).


Remember that:
f / x1
TRS =
f / x2

in our case:
1
f 1 1
= ax
+ a2 x2

a x 1
for i = 1, 2
xi
1 1 i i

from which:
a x
!1
TRS = 1 1

a 2 x 2

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

so that:
1
x2 a2 1

= TRS

x1 a1
and taking logs:
x 1 a
!
ln ln |TRS | + ln
2 2
= ,
x1 1 a 1

and we can apply the denition:

d ln(x /x )
2 1 1
= = .
d ln |TRS | 1
Tramontana Exercises Micro
Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.3

Dene the output elasticity of a factor i to be


f (x) xi
i (x ) =
xi f (x)

If f (x) = x x , what is the output elasticity of each factor?


a
1
b
2

Let us rst calculate the partial derivative of the production


function with respect to the factor x : 1

f (x)
= ax1a1 x2b
x1

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

from which we have that:


f (x) x1 ax x a b

1 (x ) = = 1 2
=a
x1 f (x) xx a
1
b
2

and with a similar reasoning:

f (x) x2 bx x a b

2 (x ) = = 1 2
= b.
x2 f (x) xx a
1
b
2

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

Note that the same elasticity can be calculated through the


following alternative denition:
d ln f (x)
i (x ) =
d ln x i

In our case we have that:


ln f (x ) = ln x x = ln x + ln x
a
1
b
2 1
a b
2

that is
ln f (x ) = a ln x + b ln x
1 2

and nally:
d ln f (x) d ln f (x)
1 (x ) = =a ; 2 (x ) = =b .
d ln x1 d ln x 2

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.5

What is the elasticity of scale of the CES technology x + x


1/
1 2
?

Let us start by recalling that the elesticity of scale is dened as:

dy (t ) t

e (x) =
dt y =t 1

or:
df (t x) t

e (x) =
dt f (t x) = t 1

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

For the CES function we have that:


f (t x) = (tx ) + (tx2 ) =t x + x
 1/ 1/
1 1 2

that is:

f (t x) = tf (x).
The CES function exhibits constant returns to scale.
In particular:

df (t x) t dtf (x) t

e (x) = = = 1.
dt f (t x) = t 1
dt tf (x) = t 1

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

Again, we should obtain the same result by using logarithms.


The elasticity of scale can be written as:

d ln f (t x)

e (x) =
d ln t = t 1

In our case:
1
ln f (tx ) = ln t + ln x + x

1 2

so:

e (x) = 1.

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.9

Consider the CES technology f (x , x ) = a x + a x . Show


1/
1 2 1 1 2 2

that we can always


 write this in the form
f (x , x ) = A() bx + (1 b)x
1 2 1
 /
2
. 1

We need to use some algebraic trick in order to solve the problem.


a + a2
Let us multiply the parameters a and a by = 1:
1
1 2
a 1 + a2

# 1
(a + a )a (a + a )a
"
f (x1 , x2 ) = 1 2 1 x1 + 1 2 2 x2 .
a1 + a2 a1 + a2

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

Now we can write:


# 1
a a
"
1
f (x , x ) = (a1 + a2 )
1
x + 2
x
1 2
a 1 + a2 1
a 1 + a2 2

a a
and by noting that = 1 we can nally have:
2 1

a 1 + a2 a 1 + a2

f (x , x ) = A() bx + (1 b)x
  1/
1 2 1 2

1 a
where A() = (a + a ) and b = .
1
1 2
a +a 1 2

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.11

For each input requirement set determine if it is regular, monotonic


and/or convex. Assume that the parameters a and b and the
output levels are strictly positive.

Remember that a input requirement set is regular provided that


V (y ):
closed (it must include its own boundary)
non-empty (each positive level of output can be produced)

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.11 (a)

(a) V (y ) = {x , x : ax log y , bx log y }


1 2 1 2

This is a case in which the isoquants look like the isoquants of the
Leontief technology.
The main dierence is that output is measured in terms of log y :

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

As for the Leontie technology, V (y ) is closed, non-empty


(regular), monotonic and convex.

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.11 (b)

(b) V (y ) = {x , x : ax + bx y , x > 0}
1 2 1 2 1

In this case the isoquants have the following shape:

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

It follows that V (y ) is non-empty but not closed, so it is not


regular.
In fact:
you can produce the quantity y with combinations of inputs in
which x is arbitrarily low, but not equal to 0. So the input
1

requirement set does not contain one of its boundaries.


V (y ) is also monotonic and convex.

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Exercise 1.11 (c)


(c) V (y ) = x , x : ax + x x + bx y

1 2 1 1 2 2

It is immediate to see that in this case V (y ) is regular.


In order to prove monotonicity we must calculate the rst
derivatives:
f (x1 ,x2 )
x1 = a + 2xx21 x2 0
f (x1 ,x2 )
x2 = b + 2xx11 x2 0

so V (y ) is monotonic.

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

To prove that the isoquants are convex, it is sucient (but not


necessary) to show that the production function is concave.
We need to calculate the Hessian matrix, so we need the second
derivatives:
32 1 1 1
f (x1 ,x2 )
x12
= 14 x1 x2
2
f (x1 ,x2 )
x1 x2 = x2 x2
1
4 1 2

12 12 1 3
f (x1 ,x2 )
x1 x2 = 1
4
x x
1 2
f (x1 ,x2 )
x22
= x2x 2
1
4 1 2

that are the elements of the Hessian matrix.

Tramontana Exercises Micro


Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11

Solution

The principal minors are:


3 1
D 1 = 14 x1 2 x22 < 0
D 2 = 16 x1
1
x2 161 x11 x21 = 0
1 1

so the Hessian matrix is semi-denite negative, the production


function is concave and the input requirement set is convex.

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.3

Calculate explicitly the prot function for the technology y = x , for


a

0 < a < 1 and verify that it is homogeneous and convex in (p , w ).

We know (also from the Example in the text) that the rst-oder
condition is given by:
pax a 1
= w,
while the second-order condition is satised when a 1.
By expliciting x we obtain the factor demand function:
1
w a1
!
x (p , w ) =
ap

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

The supply function is obtained by putting the factor demand


function into the production function:
a
w a1
!
y (p, w ) = f (x (p, w )) = ,
ap
from which we nally have the prot function:

a 1
w a1 w a1
! !
(p , w ) = py (p , w ) wx (p , w ) = p w .
ap ap
Tramontana Exercises Micro
Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

Let us prove homogeneity:

a 1
w a1 w a1
! !
(tp , tw ) = tp tw = t (p , w ),
ap ap
then the prot function is homogeneous of degree 1.
In order to prove convexity, it remains useful to see the prot
function as follows:
1 a a 1 1 a
(p , w ) = p 1a w a1 a 1a a 1a = p 1a w a1 (a),
 

with (a) is strictly positive, provided that 0 < a < 1.


Tramontana Exercises Micro
Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

The Hessian matrix is dened as:


2 (p , w ) 2 (p , w )

D 2 (p, w ) =
p2 p w
(p , w ) (p , w )

2 2

wp w2

that in our case is:


2a1 a a 1
p 1a w a1 (1aa)2 p 1a w a1
!
a
(1a)2
= a 1 1 2a (a),
( )2 p 1a w a1
1
a
a
a
(1a)2
p 1a w a1

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

whose principal minors are:


2a1 a
1 = a
(1a)2
p 1a w a1 (a) > 0 , 2 = 0 .

So, the Hessian matrix is a positive semidenite matrix and:


(p , w ) is convex in (p , w ).

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.4

Let f (x , x ) be a production function with two factors and let w


1 2 1

and w be their respective prices. Show that the elasticity of the


2

factor share (w x /w x ) with respect to (x /x ) is given by


2 2 1 1 1 2

1/ 1.

Let us note that in logarithms the mentioned elasticity is calculable


as follows:
d ln(w x /w x ) 2 2 1 1
,
d ln(x /x ) 1 2

but by using the properties of logarithms we have that:


ln(w x /w x ) = [ln(w /w ) + ln(x /x )] .
2 2 1 1 1 2 1 2

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

Therefore,
d ln(w x /w x ) d ln(w /w )
1.
2 2 1 1 1 2
=
d ln(x /x ) 1 2 d ln(x /x )2 1

Now, from the prot maximization condition we obtain that:


f
w
|TRS | = x1 1
= ,
f
x2
w 2

so the formula of the elasticity can be written as:

d ln(w /w ) d ln |TRS |
1 = 1
1 2

d ln(x /x )
2 d ln(x /x )
1 2 1

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

d ln |TRS |
but is the inverse of the elasticity of substitution , so
d ln(x /x )
1 2

nally we have that the required elasticity is given by:

1
1

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.5

Show that the elasticity of the factor share with respect to (w /w ) 2 1

is 1 .

The elasticty of the factor share with respect to (w /w ) can be 2 1

calculated as follows:
d ln(w x /w x
2 2 1 1 )
.
d ln(w /w )
2 1

From Exercise 2.4 we know that:


ln(w x /w x ) = [ln(w /w ) + ln(x /x )] ,
2 2 1 1 2 1 2 1

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Solution

so we have that:
d ln(w x /w x ) d [ln(w /w ) + ln(x /x )] d ln(x /x )
= 1
2 2 1 1 2 1 2 1 2 1
= ,
d ln(w /w )
2 1 d ln(w /w ) 2 1 d ln |TRS |
and nally:

d ln(w x /w x )
= 1.
2 2 1 1

d ln(w /w )
2 1

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Outline

1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.7 (a)

The production function is f (x ) = 20x x and the price of output


2

is normalized to 1. Let w be the price of the x input. We must


have x 0.
(a) What is the rst-order condition for prot maximization if
x > 0?

We know that:
(x ) = f (x ) wx = 20x x 2 wx

from which we obtain the rst-order condition:

0 (x ) = 20 2x w = 0.

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.7 (b)

(b) For what values of w will the optimal x be zero?

From the previous point we know that the optimal level of input is
given by:
20 w
x =
2
which is equal to zero provied that:

w = 20
but also if w > 20, in fact the input level cannot be negative.

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.7 (c)

(c) For what values of w will the optimal x be 10?

We must solve:
20 w
x = = 10
2
from which:

w = 0.

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.7 (d)

(d) What is the factor demand function?

The factor demand function comes from the rst-order condition by


expliciting x :
20 w w
x= = 10
2 2
but given the physical restriction concerning the non-negativity of
the input's level we should write:

x = max {10 w /2, 0} .

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.7 (e)

(e) What is the prot function?

The prot function is a function of prices.


Until now we have:
(x , w ) = 20x x 2 wx = (20 w x )x

but now we can use the optimal level of input to obtain:

w
!2
(w ) = 10 .
2

Tramontana Exercises Micro


Exercise 2.3
Technology Exercise 2.4
Prot maximization Exercise 2.5
Exercise 2.7

Exercise 2.7 (f)

(f) What is the derivative of the prot function with respect to w ?

From the prot function obtained in the previous point we can


easily calculate the derivative:
w 1
! !
0 (w ) = 2 10
2 2
that is:
w
!
(w ) = 10
0
,
2
which is the negative of the factor demand, as we should expect.
Tramontana Exercises Micro